With the US elections
approaching next week, as well as the threat of another fiscal cliff showdown
looming, we asked contributing editor Charles Hugh Smith to revisit his earlier
work on how
the expansive Central State has come to dominate both private society (i.e.,
the community) and the marketplace, to the detriment of the nation’s social and
economic stability. In this updated installment, we will examine six critical
dynamics that will lead to the devolution of Peak Government.
Massive Borrowing
In a misguided attempt to
maintain an unsustainable Status Quo, the Federal government is
borrowing unprecedented amounts of money that then must be serviced.
And the Federal Reserve is expanding its balance sheet by trillions of dollars
(“printing money”) and intervening in stock, bond, and other markets for the
purposes of managing perception (“the recovery is here!”)
These government funds are
not just paying the government’s bills – they are being used to
guarantee loans and mortgages that subsequently enter default, transferring
what was private debt to the public and subsidizing politically powerful
special interests.
Guarantees and subsidies
both incentivize what is known as moral hazard: the separation of
risk from consequence. This can be summarized very simply. People
who are not exposed to risk act completely differently than those who are
exposed to risk. When risk has been transferred to the taxpayers by
guarantees, give-aways, and subsidies, then speculation and mal-investment are
incentivized. If the bet pays off, I get to keep the gain, but if it
loses, then I personally lose nothing, as the loss is transferred to the
taxpayers.
Institutionalized
Mal-Investment
The net result of these
policies – borrowing immense sums to prop up an unsustainable Status Quo and
institutionalizing moral hazard – leads to misallocation of scarce capital on a
grand scale. In effect, the money borrowed by the federal
government and electronically printed by the Federal Reserve is mal-invested,
because those receiving the funding are personally not at risk and face no
consequence if the money is squandered on speculation or unproductive programs.
Once moral hazard has been institutionalized, it becomes a positive feedback
loop. Since everyone in the system faces little personal consequence from
mal-investment, the institution loses the ability to police itself.
Even worse, concentrations
of private wealth readily influence public institutions via lobbying and
political contributions, exacerbating moral hazard and mal-investment of the
publicly borrowed money.
Erosion of Trust in
Government
Mal-investment inevitably
yields poor results, and just as inevitably, the government seeks to mask the
dismal results of moral-hazard riddled policies and agencies. This
“perception management” is driven by political expediency, as public outrage at
failed policies and unproductive spending would eventually lead to a political
price being paid by the leadership. So failed policies are
declared great successes, negative data is massaged into positive data, and
unflattering frauds involving public funds are buried or transformed into
pseudo-realities.
This institutionalization
of mal-investing borrowed funds and the politically expedient falsification of
fact to manage perceptions have a destabilizing consequence: The public loses
faith in public institutions.
Diminishing Returns on
Public Debt
Massive borrowing also has
a consequence. Interest on the immense sums being borrowed squeezes out
other government spending.
This triggers two
self-reinforcing feedbacks. Public spending that is not rewarding moral hazard is cut, as
those in charge protect their perquisites, and taxes on what’s left of the
productive economy increase, reducing the private investment that is the
bedrock of capitalist growth and innovation.
This institutionalized
mal-investment leads to diminishing return. Where each dollar of
additional public debt generated nearly a dollar of additional GDP in the early
1960s, now borrowing a dollar generates negative growth, as the cost of
servicing the debt exceeds the meager yield. Thus the Federal government
borrowed and spent a staggering $6 trillion in a mere four years (2008-2011),
while the GDP has yet to return to 2007 levels when measured in real
(inflation-adjusted) dollars.
All these forces reinforce
each other in a death spiral. As trillions more are borrowed,
interest payments crowd out spending, causing the Central State to borrow even
more, which generates even more interest costs, and so on. As moral
hazard infects the entire government and its numerous private contractors and
beneficiaries, there are few constraints on rising public debt and
mal-investment of public funds. As trust in institutions that
increasingly depend on perception management rather than real solutions
declines, public faith in government deteriorates further.
The Hidden Tax of Inflation
and the Institutionalization of Falsification
The government has
one trick to create the illusion that it is “keeping its promises.”
It prints money to meet its obligations, depreciating the nation’s currency by
expanding the money supply. Creating money out of thin air does not
create wealth, productive assets, or prosperity. What it does is lower
the purchasing power of money, which we call inflation.
Inflation robs every holder
of the currency and is effectively a form of government-sanctioned theft, or if
you prefer, a hidden tax on productivity, as productive people and enterprises are taxed
to support crony-capitalist, unproductive mal-investments and the rising
interest on public debt. In effect, inflation is a way of transferring wealth
from the productive to the unproductive, which then leaves the productive with
less capital to invest in innovation. This starves the economy of capital while
robbing purchasing power of every citizen, establishing a positive feedback
loop of lower income, lower capital formation, and lower productivity.
Since the government has
obligated itself to adjust Social Security payments to inflation, the culture
of understating inflation (i.e., falsifying data) has been institutionalized,
for the Central State has the impossible dual mandate of increasing inflation
so that it can meet its obligations with cheaper money while keeping the
inflation-indexed cost-of-living adjustments low, lest program costs balloon
out of control.
A “modest” rate of 3%
inflation will, in a decade’s time, reduce the purchasing power of stagnating
paychecks by a third, while setting the “official” rate of inflation at 2% or less will
inexorably reduce the purchasing power of Social Security payments.
If the rate of inflation
was to rise at a rate similar to that of the late 1970s, i.e., 10% to 12% per
year, while the “official” rate was held to half the real rate, all those whose
incomes did not rise by 10% a year would be impoverished as the purchasing
power of their incomes evaporated. Meanwhile, even as its policies
impoverish most of its citizens, the Central State would assure everyone that
it was meeting all of its obligations as promised. This is how trust in
government is not just eroded but ultimately destroyed.
Self-Reinforcing Feedback
Loops of Self-Interest
Government at all levels
responds to shrinking tax revenues from a declining economy and budgets
squeezed by higher interest payments by seeking additional revenues by whatever
means are at hand. Tax rates are raised, junk fees are imposed, fees for minor
infractions are jacked up, and deductions and exclusions are eliminated.
The public that does not
work for the government (that would be five-sixths of the workforce)
increasingly resents what it perceives as predatory extortion in
an economy where everyone’s disposable income is falling.
Unfortunately, there is a
great divide between those who work (or worked) for the government and those
who work in the private sector. Those in government service
understandably view the promises made to them in good times, eras that we now
understand were brief speculative bubbles, as sacrosanct.
The promises were based on
the abnormally high returns earned by pension funds in the brief windows of
speculative frenzy, and even supposedly conservative pension funds based their
projections on annual yields of 6% to 8%. As the Federal Reserve has
attempted to reignite borrowing by lowering interest rates to near-zero,
low-risk yields have fallen to 3%, less than half the expected returns.
As a result, there
is a massive and sustained shortfall of public-employee pension funding, a
shortfall that must be paid out of general tax revenues at a time when those
revenues are declining as employment and business activity stagnate.
The net result in many
communities is that schools and other local services are falling apart
as budgets are slashed to meet skyrocketing pension obligations. From
the point of view of parents, the pension promises that government employees
hold as sacrosanct were unrealistic, and what should be sacrosanct (but is not)
is the education of their children.
Those of us in the private
workforce with spouses, relatives, and friends in government service understand
the frustration of those who work for government, but should the self-interest
of the few dominate the public budget and chart the course for the many?
The key difference
is that the government holds the power of coercion and the citizens do not. Thus
those in government who seek to serve the interests of their unions,
colleagues, departments, and agencies can impose fees and taxes on all citizens
to fund their own perquisites and power.
From the point of view of
those inside government, sharply rising parking tickets, higher property taxes,
and so on are small prices to pay for essential services. But as citizens
observe government services degrading even as fees and taxes increase, they see
little value being added, even as self-service and moral hazard remain in
institutionalized abundance.
Two destructive feedback
loops are generated by this divide: Governments, desperate for more revenues,
ignore public resentment and loss of trust, which only deepens the disconnect
between those in government and the public. And the private citizenry
sees a lack of accountability, soaring public debt, accounting trickery,
political dysfunction, and mal-investment of public funds as the hallmarks of
their government.
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